As we swing into the political season ahead of the unveiling of the 12th Five Year Plan, the question on many minds is whether (and to what extent) “indigenous innovation” is going to be at or near the top of China’s policy imperatives in the coming half-decade. This is not an idle concern.

The past several years have given the government and the Party plenty of time to not only think more carefully about the value of innovation for its own sake, but also of the unintended consequences of embracing the appearance of innovation as much (if not more than) innovation itself. What is more, I detect here in the capital a growing realization that not all worthy innovations come out of the labs of state-owned enterprises.

And none too soon. A recent article in Fast Company (“Motorhead Messiah“) on the work of independent automotive engineer Johnathan Goodwin underscores the last point (apologies for the long pull-quote):

Goodwin, a 37-year-old who looks like Kevin Costner with better hair, is a professional car hacker. The spic-and-span shop is filled with eight monstrous trucks and cars—Hummers, Yukon XLs, Jeeps—in various states of undress. His four tattooed, twentysomething grease monkeys crawl all over them with wrenches and welding torches.

Goodwin leads me over to a red 2005 H3 Hummer that’s up on jacks, its mechanicals removed. He aims to use the turbine to turn the Hummer into a tricked-out electric hybrid. Like most hybrids, it’ll have two engines, including an electric motor. But in this case, the second will be the turbine, Goodwin’s secret ingredient. Whenever the truck’s juice runs low, the turbine will roar into action for a few seconds, powering a generator with such gusto that it’ll recharge a set of “supercapacitor” batteries in seconds. This means the H3’s electric motor will be able to perform awesome feats of acceleration and power over and over again, like a Prius on steroids. What’s more, the turbine will burn biodiesel, a renewable fuel with much lower emissions than normal diesel; a hydrogen-injection system will then cut those low emissions in half. And when it’s time to fill the tank, he’ll be able to just pull up to the back of a diner and dump in its excess french-fry grease—as he does with his many other Hummers. Oh, yeah, he adds, the horsepower will double—from 300 to 600.

“Conservatively,” Goodwin muses, scratching his chin, “it’ll get 60 miles to the gallon. With 2,000 foot-pounds of torque. You’ll be able to smoke the tires. And it’s going to be superefficient.”

He laughs. “Think about it: a 5,000-pound vehicle that gets 60 miles to the gallon and does zero to 60 in five seconds!”

The dutiful production of a string of novel and interesting inventions may fluff the national ego and build an increment of soft power among the global geekocracy. But as the modern histories of America and Japan suggest, is the rapid industrialization of innovation, the process of taking something out of a lab or garage and making it accessible to the widest number of people, that creates economic value.

If China is going to reinvent its economy as a cradle of high-value innovation, it has to start figuring out where its Goodwins are, and how to bring them in from the cold.

I suspect that there are hundreds, if not thousands, of Johnathan Goodwins scattered around China, each with a brilliant idea that could propel a company, a sector, an industry, or even perhaps the entire economy. But something is keeping them from standing up. And it is that same thing, I reckon, that keeps Johnathan Goodwin from giving up on GM and Ford ever paying for his ideas and instead coming to China to sell them to SAIC, or Beijing Auto.

Time to stop bankrolling high-cost, low-return projects to try and reinvent the microprocessor or build a cheaper 757. Fix the Goodwin problem, and China will become a global leader in innovation.

As the 12th Five Year Plan rolls out, read through the fine print and see if the country is starting to move in that direction. Otherwise, expect “indigenous innovation” to become nothing more than a fig-leaf for import substitution and subsidies for SOEs to continue reinventing wheels.

In an excellent article in today’s Wall Street Journal, Alison Tudor notes that Chinese firms are increasingly targeting consumer and media companies in their acquisition efforts abroad. Whether or not you agree if this is a new trend, Tudor’s review of China’s challenges in this effort is very good.

I say that because in particular her identification of communications issues as an M&A barrier comes up just below the fold:

Expansion-hungry Chinese companies are likely to encounter some of the same resistance that has snarled foreign deals in nonconsumer industries. To ease fears of the “800-pound gorilla that’s called China,” acquirers should communicate extensively with regulators and the public before pouncing, said Fred Hu, chairman of Primavera Capital Corp.

The good news in this story is that the warning comes not from another communications professional, but from the chairman of a respected investment house. Now that the bankers have caught on to the problem, the question is whether the prospective Chinese acquirers plan to do anything about it.

While having coffee this morning with a good friend who is about to take a senior position with a U.S. industry association in Beijing, the discussion turned, as it often does these days, to America’s continued worries about China. As we talked about the various policy issues he is likely to face, I realized we are looking at the wrong problem.

Much of the posturing in Washington and the media coverage on Sino-US relations see America’s primary challenge with China’s rise as a matter of getting China to play by global rules.

In fact, the most difficult thing for Americans to accept may be China compelling America to play by the very rules it has espoused for decades.

Standard Deviations

There are several examples, but the one that leapt to mind was in the matter of standards. America preaches to China about accepting global standards rather than creating its own. We see the creation of the TD-SCDMA wireless broadband standard, the WAPI wireless area network standard, the CMMB mobile television standard, and the EVD video standard as protectionism against WCDMA, Wi-Fi, DVB, and Blu-Ray.

We forget, of course, that America and Europe have done the same in the past. The ATSC digital television standard was created as a rejection of a European-developed one. Europe, for its part, created the PAL television standard and the WCDMA mobile standard to get out from under the American thumb.

White Man Speak with Forked-Tongue

Standards are but one example. The history of American trade is rife with the very sort of protectionism and import-substitution for which we chide China. As Bloomberg BusinessWeek noted last month in an article entitled “China: Closing for Business?:”

China sees how other countries—notably the U.S.—have used standards, regulations, and buy-local policies to build their own industries. Beijing feels more than entitled to do the same. The U.S. Trade Representative’s Office started 28 cases against Chinese companies last year. And “states like California have wide latitude in their procurement policies, so they can give American companies an advantage,” explains Nicholas Lardy, senior fellow at the Peterson Institute for International Economics.

We are about to learn the cost of allowing our behavior to deviate from our principles.

China Rules

Whenever we behave in a manner divergent from accepted principles in international affairs, we make a de facto change in the rules. It is not acceptable in an increasingly multi-polar global polity to implore others to “do as we say, not as we do/did” merely because we have mended our ways. A priest may forgive you for past sins: diplomacy lacks such absolution.

That truism will bedevil all of our efforts to get China to play ball by our rules. Worse, though, it gives China wherewithal to make a global case for us to make amends for our own past sins.

The lesson for business is plain: we have to recognize that there is a new set of rules governing the international business environment. Our job as executives is to learn how to succeed under those new rules.

In the October Vanity Fair, the magazine offers us its list of “New Establishment” leaders. In the entry on Steve Ballmer, the magazine whacked the Microsoft CEO for what it felt was a bad call:

BROKEN CRYSTAL BALL: Three years ago Ballmer proclaimed, “There’s no chance that the iPhone is going to get any significant market share. No chance.” (The iPhone is now the No. 2 smartphone, with a 28 percent market share.)

Meanwhile, Outside the Manhattan Vortex…

Not defending Ballmer, but the editors at Vanity Fair would have done well to ask “market share of what, exactly” before taking the Head Microsoftie to task. Assuming Mr. Ballmer was talking about global handset market share, Vanity Fair‘s editors are wrong to spank the Monkeyboy. For if said editors would teleport themselves ever-so-briefly off of the island of Manhattan, they would find that the world is not made up of iPhone-toting fashionistas.

Take a single, very large example. In China, the largest mobile phone market on the planet, a mere 400% larger than the U.S., smartphones make up well under 10% of the market, and as of Summer Apple’s share in China was less than one half of 1% of the total installed base even after three years of grey-market and nine months of “legitimate” iPhone sales. In China, at least, Ballmer is right.

But does Apple really care about market share? What Vanity Fair and Steve Ballmer both missed is that even if Apple owned only 5% of the global mobile handset market, at a retail price of $300 per phone that’s something like $15 billion per year.

They are not alone. What many people miss in the growing battle between Android and Apple is that Apple, as it did when it introduced the Macintosh in 1984, as made an implicit decision to capture and hold the high end of the mobile devices market, and ignore everything else. (Before we go any further, for the sake of full transparency, Motorola is one of my clients.)

Leadership is Overrated

In light of the evidence, one can hardly blame them. Ericsson watched its onetime market leadership wither as it failed to pace consumer tastes, leaving the company a shriveled rump of a joint venture with Sony. Motorola, once the leader of the market it created, watched its mid-decade quest to build market share on the foundation of a halo product founder as the halo (the RAZR) slowly tarnished.

And today, Nokia is finding that the demands of sustaining global share leadership are incompatible with the challenges posed by a changed industry. Nokia may sell more phones than any other company, but it has found the rewards of that title increasingly ephemeral.

And so Apple has decided not to try to be the largest mobile device company in the world, but the most profitable. We should not expect from Apple a line of iPhones so much as we should expect successive generations of innovative devices.

These Are the Droids You’re Looking For…

As a part of that decision, Apple has chosen to be a company that plays to developed, wealthy markets and wealthy niches within developing markets. The iPhone is not The People’s Phone. Never would the company consider the bottom or middle of the world’s income pyramids to be a market for anything it produces. Apple makes powerful, pretty devices for the prosperous. Full stop. (And there is nothing wrong with that: just ask an AAPL shareholder.)

For that reason, Apple’s “leftovers” constitute a growing market: legions of users who want access to highly portable, customizeable, low power devices that provide easy-to-use wireless access to the Internet, services, and entertainment, and yet cannot afford the cost of entry into the Apple ecosystem.

And I would argue that this market needs the power of an iPhone-type device more than the global Beautiful People who can afford one.

Enter the Androids.

Over the past year, Motorola, Samsung, LG, and HTC have already introduced Android devices that retail below RMB3,000, and once local manufacturers have access to capable yet inexpensive components, that price will fall quickly. Kaifu Lee, CEO of tech investment house InnovationWorks, predicts that Android devices will be available for RMB1,500 in 2010, and for RMB750 in 2011.

These are tipping-point prices that will begin to push mobile Internet-enabled devices into the hands of a far wider part of China’s population. They are not price points that Apple looks prepared to play in. In all likelihood that means that there will be many more Android devices in the market than Apple devices. That is going to be fantastic for the Android device makers, a life changer for China’s consumers, and it is going to be very, very good for Apple.

Amateurs talk about Share, but Professionals talk about Margin

So the argument over market share is banal and irrelevant, and predictions of Apple owning a share of the China mobile market comparable to its position in the U.S. is so much sky pie: through pricing and positioning Apple has strategically ceded a massive chunk of the market that it helped create, and is indeed seeding demand for Android products across a wider market.

For these reasons, the determinant of success for Apple or any of its competitors in the China smart phone market is not share, but rising profits, growing sales, and happy consumers. Those things are a lot harder to call and cannot be reduced to a single hard figure, but they are much more relevant, especially when the rate of market growth for smartphones continues to grow itself.

MIT’s Yasheng Huang notes in Foreign Policy that U.S. diplomacy with China is focused on far too narrow an audience.

But to engage only with official Beijing is no longer enough. It is vital that American leaders learn to communicate more effectively with the Chinese people — lest the conspiracy theorists do the communicating for them.

Dr. Huang echoes a post I made here and in AdAge China two years ago following the election of Barack Obama, calling for a renewed and expanded public diplomacy effort in China:

First, while the government and party remain in control, the means by which decisions are reached is evolving. China is increasingly governed through a process by which consensus is reached among groups and policy makers, or as I like to say “one party, many factions.”

Second, this change has opened a window for groups outside of the government to exert more regular influence on policy making. While China’s leaders and bureaucrats still operate in a system where they are free to ignore public opinion when they forge policy, they are (for a variety of reasons) seeking more input from business leaders, academics, foreign experts, and even the public itself.

Third, this is all taking place in an environment where the role of the web is growing in China, and the permissible scope of discourse is wider than most non-Chinese appreciate.

That Dr. Huang is having to repeat the point makes clear that the Obama administration has lost an opportunity it could have taken from the beginning. That failure is now starting to erode whatever popular support the U.S. had in China, and is postponing the day when that support might be grown.

The hour is not too late, but there is no time to lose. The Chinese people have a growing influence on the conduct of Chinese foreign affairs, and the balance of power in domestic politics is and has always been the key driver of China’s foreign policy. Washington must understand that it is no longer playing to China’s Party elite. It is also playing to the masses, and thus far it has done a poor job.

After living on the Mainland for a decade and a half, I was beginning to wonder whether the subtle effects of Party propaganda were beginning to warp my view of modern Chinese history, and in particular the legacy of the First Family of the nationalist Kuomintang government, the Chiangs. They are both portrayed as villains in mainland propaganda and sainted heroes in Taiwan. Where twixt these extremes, between angels and demons, I asked myself recently, does the truth lie?

Pakula is no China expert, she is an historian and a biographer of great women, so she comes to her subject refreshingly bereft of some of the prejudices and agendas that have tainted many recent biographies of China’s leaders. She comes as a blank sheet, implores us to do the same, and in the process creates a remarkable addition to the canon of popular Chinese history.

If the sole result of Pakula’s effort was an immersive and multi-dimensional portrait of one of the most important leaders of the twentieth century, that would be sufficient reason to read this book. And it is certainly that. Pakula leads us through Meiling’s formative years, letting us watch her evolve from the idealistic scion of a New Chinese family to the dowager of a reactionary regime that sacrificed its ideology on the altar of survival.

On top of all of this, there are hints at little-discussed but critical parts of her personal life, a frank examination of her relationship with her streetwise but rather less sophisticated husband, and an examination of the family coterie that formed around her as she aged.

What lifts this book above that of an engaging character study is how Pakula delicately parallels the evolution of China’s fortunes with Meiling’s. Her spirits, her fortunes, her very personality seemed to wax to their fullest between the early and the mid-1940s, and then wane as events force her and husband further to the periphery of China’s historical mainstream.

Confronted with the complexities of a remarkable character, the temptation to simplify Madame through interpretation must have been incredible. Pakula could have easily slipped into the biographer’s version of Stockholm syndrome, allowing empathy to help her find redeeming qualities in Meiling beyond those actually present. Or she could have gone the other route, inflating Madame’s character failings into a morality tale that would have made the KMT’s weaknesses her own.

Thankfully for us and for history, Pakula takes no such shortcuts. There are no simple, spoon-fed caricatures in Pakula’s account that will allow the reader to get off so easily, to simply file Madame into one of those easy little boxes to which we consign our heroes, our villains, our perpetrators, and our victims. Instead Pakula leaves us with the facts and a charge: to parse for ourselves the rightful place for Song Meiling in the intricate tapestry of Chinese history.

I enjoyed the general direction of the piece, but was surprised to read this bit:

Foreign companies are finally wooing Chinese consumers either by designing products for them or by unveiling global brands first in the country. In September 2010, France’s Hermes will open its first Shang Xia — which translates roughly as “from top to bottom” — store in Shanghai to mark the launch of a line of ready-to-wear clothing and crafts inspired by traditional Chinese motifs. Last month, America’s Levi Strauss launched, with much fanfare, a global jeans brand, dENiZEN, in the same city. Earlier in the summer, General Motors and SAIC announced their plans to introduce a new automobile, Bao Jun (“prized horse”), for about RMB 50,000 ($7,400), which is lower than the price at which the Chevrolet sells in China.

Old Wine, New Bottle

The authors imply that the strategy of creating a product especially for Chinese consumers is somehow new, and that Hermes, Levi’s, and General Motors are vanguards among global brands in taking this route. As two China-based consultants with a firm as prestigious as McKinsey should know, there is nothing new about this idea, and the firms they cite are far from being the first to follow this path.

In fact, global brands have been following this approach to varying degrees of success for some time. Just a few examples:

KFC has been offering menu items like its “Lao Beijing Zhan’r” (fried chicken strips, lettuce, onions, and plum sauce wrapped in a tortilla) for nearly a decade;

Motorola developed its MING line of smartphones in China specifically for Chinese consumers, and launched the device in China in March, 2006. The device and its successors – also local creations – were huge hits for the company in China, and were eventually exported as well;

Volkswagen modified its B2 line (Passat/Quantum) to create a new car for China, the Santana. The Santana was a big seller for VW, and eventually made it to Japan, Brazil, and Mexico as well.

Procter & Gamble has been offering toothpaste products designed for local palettes for over five years that I know of, likely longer.

There are more, but you get the point.What is more, none of this dives into the vast host of products that have been heavily modified or localized for China even though they were not created here.

Lead with the Unknown?

A few observations.

First, none of the companies mentioned above is a newcomer to China. With the exception of VW, all of the companies in the above list were in China for some time before launching products specifically for China. In other words, when they started out in China they did so with global products, but began making products for China only after gaining considerable experience and insight here.

(In VW’s case, the company jumped into local production rather early. What lowered the risk of the move was that the Santana was based on the company’s B-series platform, and shared enough commonality with the Passat and Quantum that the company limited the risk of leading with a new marque.)

Second, however, the authors use the experiences of the companies above to suggest bypassing the “long and cumbersome process” of introducing a product from a home market in China and go right to creating products made for locals. In addition to ignoring the successful track record of companies entering China, it disregards the much of the history of successful globalization.

Volkswagen first succeeded in America with the Beetle, a car designed for Germans a quarter of a century before; Levi’s 501 jeans were a global favorite long before dENiZENs, Coca-Cola doesn’t seem to fiddle with its core product anywhere in the world (although packaging might change); Motorola RAZRs, Nokia 11oos, Apple iPhones, Honda Accords, Big Macs, Snickers chocolates, Louis Vuitton handbags, and Kleenex tissues were among the hundreds of global products that succeeded brilliantly in China with minimal or not change at all, even in the brand names.

Third, leading in a new market with a new product only serves to multiply the uncertainty of the market entry – uncertainty about the market, uncertainty about the product. If the product doesn’t go over well, is it the problem of the product, or is it a market-specific issue? If it does go well, what has been learned for the future?

The authors seem to assume a degree of perfection of information that simply does not exist in the real world, no matter how much market research you do and how many expensive consultants you hire. Success in any market relies on educated guesses and the ability to endure through a period of trial and error before getting your product right. Sometimes you stumble into it by dumb luck.

To do that cheaply means starting out be selling what you’ve already got in the bag, and applying what you learn to localize, modify, and finally create from scratch the right products and services for the market.

Of course, McKinsey probably wouldn’t make much money advising clients to throw a whole bunch of stuff at the wall and see what sticks. On the other hand, maybe, if they called it “The Vertical Planar Adhesiveness Stratagem…”

The monitoring and censorship of China’s Internet is a matter of continuous outrage and fascination for audiences outside of China. And why not? It is superb theater. It pits the world’s extremist information libertarians against a faceless bureaucracy seeking to control information flow, and it provides a public forum to watch and gauge China’s evolving polity. As a result, the topic is of great interest to reporters covering China.

Most of the time, the attention journalists give to this ideological tug-of-war is either good, or at worst harmless. But there is one type of story that, when reporters cover it, they have the potential of doing a great deal of harm: what I call “loophole stories.”

Guess Who’s Reading Your Story?

Recently a reporter for a large global wire service ran a story wherein he/she revealed that owners of Amazon’s Kindle e-book reader devices in China could use the device’s built-in browser and circumvent the systems put in place by Chinese authorities to restrict access to websites deemed unsuitable for local audiences. The story has run, at my last count, in over 150 publications and websites in English alone around the world.

I understand the urges that motivated that reporter to cover the story: the sheer glee that China’s regulators had been foiled again, and the urge to pander to readers who would read the story as a triumph of technology over censorship.

But the consequences of running that story will be something else altogether.

Translators working at the Xinhua News Service, China’s wire service agency directly subordinate to the State Council Information Office, will see the story as they monitor the global news wires to which Xinhua subscribes. They will translate the story and, rather than run it over their own wire, they will include the piece among the stories that will be passed as a part of a daily internal briefing to the senior leaders of the government and Party.

Once the pesky loophole is called to the attention of the senior leadership, it must be dealt with, if for no other reason than to prove that the nation’s regulators are not the Keystone Kops the story implied they were. A way will be found to isolate Amazon’s Whispernet network and block it in China.

Loophole closed.

Congratulations, intrepid reporter. You will have assisted the authorities in making the censorship lid on China’s Internet all that much tighter. If it was your intention to do so, job well done. Your fellow foreign correspondents will, I am sure, be so proud.

Knowing When NOT to File

The pressures on a modern journalist, especially a wire service journalist, are brutal. Not only do you need to make sure you have every worthwhile story on your beat, you must also ensure that you file before everyone else. There is not a lot of time to weigh the moral and ethical issues around any given story.

But in a place like China, where the unintended consequences of a story could range from the infuriating to the downright deadly, those consequences must be understood and weighed. And when you have a doubt, you must have the courage to spike the story.

Gady Epstein and Imagethief have offered spot-on commentary about Mengniu‘s alleged hiring of a Beijing PR firm to disseminate libelous disinformation about a competitor. This sort of extreme case makes a good story, and hopefully there will be a few visible prosecutions to ensure these particular practitioners never twist the truth again.

But there are a wide range of activities in the public relations industry in China that, while they would be considered unethical or illegal elsewhere, are accepted practices here. While the practices in isolation may not seem egregious, they create an atmosphere of permissiveness that undermines the effort by many public relations people, both Chinese and foreign, to move public relations out of the sewer and into the boardroom.

Practices I have witnessed in the past decade include:

Corporations and their public relations firms paying reporters a “transportation fee” of anywhere from RMB 200 – RMB 700 simply to come to a press conference or an interview, regardless of any relationship that fee has to the actual costs incurred.

Public relations firms writing pro-client stories – essentially press releases in the style of a feature – for reporters to publish under their own bylines.

PR firms pricing their services on a per-published-word basis, who, after taking a cut, then pay reporters to write reams of laudatory copy in return for a gratuity for each word published.

Companies entertaining reporters at expensive restaurants, plying them with expensive gifts, or taking them on junkets.

Companies buying ads in newspapers in order to keep those publications for writing negative stories about them, with the reporter taking a commission on ad sales.

Companies paying PR firms to hire people to go onto online forums and pretend to be consumers who love their company’s products (or who hate a competitor’s products). (We call it “astroturfing” because it fakes grassroots sentiment.)

These are not practices followed by all PR people or companies in China. There are firms and clients who are willing to put themselves at a short-term disadvantage in order to keep their practices above reproach, and they do so quietly. But the ethically-challenged practices remain altogether too common.

Until they are stamped out or drastically reduced, they will not only foster more scandals, they will undermine the credibility of China’s maturing news media in the eyes of the public. The government and the Party can afford neither. And therein lies a great danger for the PR business.

A PR industry truly interested in its future would move to put a stop to practices that may be considered unethical. If the motivation of protecting their clients against the kind of official attention Mengniu is getting these days is not enough to provoke a change, perhaps the specter of the government stepping in to regulate the industry in detail will be.

The global PR industry is not without its considerable ethical failings. Indeed, I reckon I will spend the rest of my professional life in a quixotic battle against spin as a substitute for true communications.

But it is early days in the evolution of China’s own craft of corporate communications. It would be a regrettable pity if that craft were to dissolve itself in the acids of disinformation and ethical compromise, right when it – and the companies it advises – most desperately needs to learn to communicate.